Direct vs. indirect loss

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You have a contract with a third party.  It is on the third party’s terms and conditions.  The other party breaches the contract.  You bring a claim in respect of your loss.  The other party refers to its terms and conditions and in particular an exclusion /  limitation of liability clause that excludes liability for all indirect and/or consequential loss.

What can you recover?

This question arises time and time again.  Given the amount of litigation on the subject you would expect that the answer would be clearly articulated by now in a wealth of judicial decisions. 

However, as with so much of the law, the answer in each case tends to lie in the facts of that case and, in this instance, in what was in the reasonable contemplation of the parties at the time that they made the contract. 

It is a common misconception that loss of profits and other financial losses would always be indirect or consequential and therefore potentially caught by an exclusion / limitation of liability clause.  What might be a direct loss in one case may be a consequential loss in another.  This could be illustrated by comparing a financial loss that results from a supply of a building product with a financial loss that arises from the supply of a complex piece of software.  In the latter case financial loss is likely to be the most direct loss if the software turns out to be defective but that would not necessarily be the case with the construction materials where the key purpose is likely to be rather more functional.  In that case financial loss might well be regarded as a consequential loss and so caught by the exclusion or limitation of liability. 

Insofar as it is possible to draw a legal distinction between direct and indirect loss, it is as follows:

a)  Direct loss is that which flows naturally, according to the normal course of things from the breach of contract itself, i.e. the losses that the reasonable person might expect the relevant breach to produce. 

b)  Indirect or consequential loss is such other loss as may reasonably be supposed to have been in the contemplation of the parties at the time they made the contract as a probable result of the breach, i.e. any other losses that the party in default might expect the relevant breach to produce taking into account its actual state of knowledge and any other relevant considerations.

The fact that the distinction between direct and indirect loss can be so context specific makes it important that consideration is given to the potential type of loss that might flow from a breach before a contract is entered into.

Whilst many parties when they come to negotiate their contracts are often more concerned with other matters than provisions that only come into play if something goes wrong (because not unnaturally most people like to believe that things are not going to go wrong) one of the lessons of litigation is that it is worth spending some time and effort on this to identify the type of losses that might arise if the contract goes wrong and to specifically negotiate whether those losses will be excluded or not.  Another approach is to specifically include all the possible types of loss in the contract so removing some of the uncertainty that traditionally surrounds these issues if they come to be litigated.